June 2, 2013 / 7:17 PM / 6 years ago

BIS lays out "simple" plan for how to handle bank failures

LONDON (Reuters) - Central bank forum the Bank for International Settlements laid out a blueprint on Sunday for how to recapitalize a major lender in the event of a failure, seeking to avoid the sort of chaotic ad hoc rescues seen since 2008’s financial crash.

Authorities have been grappling since the collapse of U.S. investment bank Lehman Brothers five years ago with the question of how banks regarded as systemically important - or too big to fail (TBTF) - can be recapitalized without causing panic and without needing taxpayer cash.

The BIS paper released on Sunday said its plan would allow banks to be recapitalized quickly and easily and would allow authorities to give an unequivocal guarantee that insured depositors would not lose savings.

“(It) proposes a simple recapitalization mechanism that is consistent with the rights of creditors and enables recapitalization of a TBTF bank over a weekend without the use of taxpayers’ money,” the paper said.

Under the template laid out by BIS, which is termed a creditor-funded recapitalization mechanism, the bank would undergo a forced recapitalization by its creditors when it reaches the point of failure.

The ownership of a bank would be transferred to a newly created temporary holding company over a weekend. The bank is then immediately recapitalized by writing off the claims of creditors.

The authors suggested the blueprint could be the only way to respect the pecking order for the repayment of creditors, achieve a quick recapitalization and prevent risk from moral hazard, when expectations of government help can encourage banks to take more risks.

The creditor hierarchy would be observed, with subordinated creditors written off and some losses imposed on senior unsecured creditors - enough to give the bank capital to easily withstand future losses and restore market confidence. That would include losses for deposits above the guarantee.

“On Monday morning, the authorities re-open the bank and can provide it with any necessary and appropriate liquidity assistance because it is now well-capitalized,” the report said.

The holding company would sell the recapitalized bank in the following months at market prices, and proceeds would be distributed to the written-down creditors.

Management and board members could be replaced between the recapitalization and sale of the bank, if required.

The plan includes elements of other resolution methods, particularly the bail-in of creditors and a holding company resolution.

Europe is pushing ahead with plans to implement a “bail-in” regime that would see bondholders and big depositors take hits.

But the bail-in model does not fully respect the creditor hierarchy, as it can inflict losses on bondholders before shareholders have been fully wiped out, said the BIS report’s authors, Paul Melaschenko and Noel Reynolds.

Reporting by Steve Slater; editing by Patrick Graham

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